Does Vaping Have 'Legs'?

NEW YORK -- Electronic cigarettes have been a great success story in the tobacco category, perhaps the greatest success story in many generations. RBC Capital Markets tobacco analyst Nik Modi estimated that e-cigarette retail sales have more than doubled each year since 2008, reaching the billion-dollar mark in 2013.

And he had data to prove it: Lorillard's own data showed industry-leader blu's sequential growth actually decreased by 14% in Dec. 2013 and by 6% in March 2014.

"It's declining year-over-year," said Modi of blu's growth. "That could just be inventory dynamics, but the point I'm trying to make is that you have this category where people are getting overheated with their hyperbolic expectations, making investments based on those expectations, and that proved to be a poor capital allocation decision. It's very important to keep a broader, balanced, rational context on this category."

Another possible explanation for the e-cig slowdown--which Modi noted is happening not just with Lorillard, but with the majority of the industry--is the increased interest in personal vaporizer products, although it's difficult to estimate just how much share this once-niche market is taking from e-cigarettes.

"It's a very fragmented industry with no legitimate data source," Modi said. "At this point, I think everyone's struggling with how big this category really is because it's so unmeasured."

As important as that data is to getting a real picture of the segment, it's the consumer interest that has Modi convinced tanks are a real trend.

"This interest is most prevalent on the West Coast," he said. "Based on my 15 years of consumer research, anything that starts out on the West Coast almost always becomes a bigger trend in the broader economy five to 10 years later. The fact that the West Coast is a hotbed for vaping means there's probably some legs to this category."

Another point for the tank and mod market is the quality--especially when compared to that of the traditional e-cigarette (often called "cig-alike") products on the market.

"The experience of the tank is much greater than the traditional cig-alike format," said Modi. "That's the key."

That key experience, according to Modi, is largely driven by a superior battery. While most traditional e-cigs are limited to batteries that will fit in a smaller, cigarette-sized product, personal vaporizers can accommodate a much larger, higher-quality battery.

"Consumers are already driven crazy by the weak batteries in cell phones and other electronic products: now they're feeling the same frustration with the e-cig category," Modi said. "For the vape devices, the batteries are extremely strong."

"The real critical research and development solution for this category is how do you get a cig-alike product with the efficacy and power of a vaporizer battery?" he continued. "That's a really tough challenge. You essentially have to shrink a battery, make it more powerful but more economical so manufacturers can make money. It's an issue I think a lot of companies are trying to tackle right now."

In the meantime, expect to see a lot of mainstream players dipping their toes in the e-liquid and vaping market. Republic Tobacco, Kretek, CB Distributors and Mistic have all launched their own vaporizer and e-liquid lines (often in addition to an existing cig-alike product) and NJOY recently made waves by announcing it too would enter the tank market this summer.

"It makes sense from a vantage point that consumers are migrating to different subsets of the category," Modi said of the NJOY announcement. "I would expect more companies to follow their lead."

The success of the vapor industry hinges on FDA regulations: but as it stands now, Modi stands by his prediction that any manufacturer wanting to be in the electronic business will ultimately need to enter this space: even Big Tobacco.

"We'll see what happens with regulations: there's a lot of ambiguity there," he said. "But I would predict most companies that aren't in the vapor category yet, will be in the next 12 to 18 months. I think they're going to be forced to."

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